Most economies experience episodes of persistent real exchange rate appreciations, when the question arises whether there is a need for intervention to protect the export sector. In this paper we present a model of irreversible destruction where exchange rate intervention may be justified if the export sector is financially constrained. However the criterion for intervention is not whether there are bankruptcies or not, but whether these can cause a large exchange rate overshooting once the factors behind the appreciation subside. The optimal policy includes ex-ante and ex-post interventions. Ex-ante (i.e., during the appreciation phase) interventions have limited effects if the financial resources in the export sector are relatively abundant. In this case the bulk of the intervention takes place ex-post, and is concentrated in the first period of the depreciation phase. In contrast, if the financial constraint in the export sector is tight, the policy is shifted toward ex-ante intervention and it is optimal to lean against the appreciation. On the methodological front, we develop a framework to study optimal dynamic interventions in economies with financially constrained agents.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13077.
Length: Date of creation: May 2007 Date of revision: Handle: RePEc:nbr:nberwo:13077
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Find related papers by JEL classification: E0 - Macroeconomics and Monetary Economics - - General E2 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment F0 - International Economics - - General F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance H2 - Public Economics - - Taxation, Subsidies, and Revenue
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Caballero, Ricardo J. & Krishnamurthy, Arvind, 2004.
"Smoothing sudden stops,"
Journal of Economic Theory,
Elsevier, vol. 119(1), pages 104-127, November.
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Ricardo Caballero & Arvind Krishnamurthy, 2001.
"Smoothing Sudden Stops,"
NBER Working Papers
8427, National Bureau of Economic Research, Inc.
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